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Question 4: Now imagine you are HPI's investment banker and you are proposing an ADR on the NYSE.

1) Discounted Cash Flows The EBIT and depreciation figures for halfyear 1994 have been doubled to reflect the figures for the entire year. The three possible ways of estimating the fair value are: Discounted Cash Flows of the free cash flows of the firm.25% Thus.61% 9. P/E ratio and Price/Book Value of International Power Generating Groups.37% 8. So. 13 .94% 12.WACC 11. P/E Comparable with PRC based companies going for recent IPOs in international markets Trading Multiples. we see that lowest cost of capital is possible only at the equity markets in the USA. US markets should be the destination for making the new issue of equity. viz. 599 1.62.62.000 .48.295 Capital Expenditures 3.000 9.12.35.62.28 Depreciation 2. However.e.91.589 3.429 2.000 1995 1996 1997 1998 1999 1.82.753 4.28.86. 9%.000 Operating Cash 1.829 6.562 1.12. The perpetual growth rate is taken at a conservative level of 4%.44.657 2. all figures in thousands 1994 Perpetuation (doubled for full year) EBIT 481163. The discount rate is the cost of capital (WACC) arrived at in Q3 for the US markets.428 2.25.37% will be in force when temporary tax holidays now received will expire.000 - 9.495 5. Taxes have been taken at the forecast level.05. i.751 76.34. the capital expenditure incurred would be just enough to offset the depreciation and maintain the existing capacity.042 76. much below the GDP growth rate of China.07. post 1999. it is assumed that longterm effective tax rate of 17. It is assumed that after 1999. The forecasts provided in Exhibit 12 have been used.000 1. 972 6.636 397585.88.530 2.772183 0.918 - 3.175 62.522 3 0.316 Free Cash Flows -44.708425 0.596267 Discounted Flows 223979.03. and taking that multiple as the proxy for estimating the fair value of shares of HPI.582 29.28 Less: Taxes 83578.952 25.687 14.00.71.128 0.448 3. For this purpose.84168 4 5.835 - 4.06 -41.05.26.Flows 481163.31 PV of Free Cash Flows Discounted Perpetuity Total Enterprise Value Less: Net Debt Equity Value Price/ADR -967387 4930995 3963608 533433 3430175 27.120 4.917431 2 4.277 6.248 20.649931 -339430 -483790 354749 14 27380.22 Year of Discount Discount rate (9%) 0.00. we have eliminated IPOs where offer size was too low compared to .757 5 6 42.305 20.5 Cash -40778 1 0.75.4414 2) P/E Comparable with recent

PRC based company IPOs Another method adopted is to estimate the mean and median P/E Ratio of recent IPOs by PRC companies in foreign markets. 2 11.1 1.47 Exchange NYSE Hong Kong Hong Kong Hong Kong Hong Kong 15. Company Shandong Huanheng Power Dongfang Electrical Tianjin Bohai Chemical Yizheng Chemical Fibre Beiren Printing Shanghai Petrochemical Tsingtao Brewery Median Mean Value of HPI shares: EPS/ADR Median Mean $ 1.35714 .5 P/E ratio 14 Hong Kong Hong Kong 13.45 19.3 16.S.575 19.367857 15 3) P/E and P/BV multiples compared to International Power Generating Groups Comparable with International PE Ratio Price to Book Ratio Power Generating Groups Asian Power Products South American Utilities U.that of HPI's.6 23 14.2 2.3 12 11.2 13.27 2. Independent Power Products U.2 15.S.24 2.5 13. Utilities 10. 64 2. that put it in a position so as to command a premium over what Shandong Huaneng Power is trading at.99188 We have also already discussed the key strengths of HPI arising from its being the largest power firm in PRC.4 14.547 21. 16 This price would ensure that the potential investors take note of the company and are happily willing . The company is in a position to command better prices than other comparable firms because of its market power and unique position.44 per ADR (as per the DCF model).1 14.6608 18. the Government support and various other privileges it enjoys.European Utilities Median Mean HPI Valuation EPS/ADR Book value/ADR Median Mean 1.86 As per P/E 1. while the said price of $ 24 is also below the real intrinsic value of the shares at $ 27. Thus. we can safely fix the price to be at $ 24 per ADR so as to attract the foreign investors into value buying.964 As per P/BV 20. The lowest price estimate we get from the above is $ 19.4 per ADR and the highest we get is $ 27.45 9. its ambitious growth plans.24 1.445 21.67 11. the attractive Chinese economy.44. China US Hong Kong UK . Missing out on expansion plans because of lack of capital would mean lose of great opportunity which can hamper the future growth of Huaneng power limited. Debt is available at low rates and a n optimum level of debt will maximize the company's value by the way of tax shield. which is 15.to pocket in the benefit to the tune of $ 3. Huaneng needs $ 4. The cost of capital for each equity option available to Huaneng is as follows. Thus. Domestic stock exchanges were still in the nascent stage and hence were incapable of raising adequate amount of liquidity.44 per ADR. how and why HUANENG should have proceeded with the issue.5 billion to finance its

duevelopment plans. such a pricing should create a win-win situation for both the company as well as the investors. Huaneng is exploring international markets to raise funds primarily because of two reasons.5 billion the best option for Huaneng would be to raise debt instead of equity.

You have to convince HPIs bearer of the price at which they should issue the shares? What is a reasonable share price? Why? .Now imagine you are HPIs investment banker and you are proposing an ADR on the NYSE. 95%. WACC found for US Growth rate: 8% (since 1978. the Chinese economy had expanded at an eeve been doubled to represent the whole year Discount rate: 8.1994 EBIT Depreciation Capital expenditure Operating Cash Flows Taxes Free Cash Flows Discounted Cash Flows Firm value Debt Equity value Price per ADR 1995 1996 1997 1998 1999 107242 76428 -225000 -41330 5836 -47166 -43291 24562274 533433 24028841 19. 36 Earnings per ADR to HPI's one.5 15.3 13. Company Exchange P/E ratio Shandong Huanheng Power Dongfang Electrical Tianjin Bohai Chemical Yizheng Chemical Fibre Beiren Printing Shanghai Petrochemical Tsingtao Brewery NYSE Hong Kong Hong Kong Hong Kong Hong Kong Hong Kong Hong Kong Mean 14 12 11.35 1. Taking the multiple to estimate the value of HPIs ADR.3 16.2 13.45 HPI valuation Price using P/E ratio IPOs by PRC firms in foreign markets. 4 14. Taking those multiples to estimate the value of HPIs ADR.1 10. International Power Generating Group Asian Power Products South American Utilities U.64 1.2 1.S.6 23 14.99 . Independent Power Products U.96 1.2 11.54 P/E ratio 15.47 1.86 P/B ratio = 2. Utilities European Utilities Mean Earnings per ADR for HPI Book value/ADR HPI valuation Price using P/E ratio 21.27 average Price Earnings and Price to Book ratios of international power generating group.67 Price using P/B ratio 18.45 9.S.24 2. 36 Multiples Comparable with International Groups Using P/E ratio Using P/B ratio $21. which is in range with the different prices we found lowest price estimated is $ 19. Government support).50 per ADR.2 per ADR and the highest is $ 21.54 $18. Knowing the strengths of HPI (largest power firm in PRC. slightly above PRC comparable firms. We propose a price of $ 20.5 per ADR. due to

its dominant market position.DCF Price per ADR growth plans. attractive Chinese economy. the company is in a position to command better prices than other comparable firms.22 Comparable with recent IPOs Using P/E ratio $19.